Deck 11: Bond Valuation

Question 1

Which of the following statements concerning bonds are correct?
I)Municipal bond interest is federally tax-free.
II)Bond yields are related to bond ratings.
III)General obligation bonds yield more than revenue bonds.
IV)At the time of issue, callable bonds have higher yields than noncallable bonds.

A) I and III only
B) II and IV only
C) I, II and IV only
D) I, II and III only

Answer 1

C

Question 2

Changes in the inflation rate have a direct and pronounced effect on market interest rates.

Answer 2

True

Question 3

The relationship between the rate of return and the time to maturity of similar-risk securities is known as the term structure of interest rates.

Answer 3

True

Question 4

The single most important factor that influences the behavior of market interest rates is

A) inflation.
B) business profits.
C) the supply of new bonds.
D) the stock market.

Question 5

The risk premium component of a bond's market interest rate is related to the characteristics of the particular bond and its issuer.

Question 6

The risk-free rate of return considers the expected rate of inflation.

Question 7

A yield curve depicts the term structure of interest rates for similar-risk securities.

Question 8

Which one of the following will tend to cause domestic interest rates to rise?

A) an increase in the money supply
B) a decrease in the rate of inflation
C) a decrease in the federal budget deficit
D) an increase in interest rates overseas

Question 9

Rank the following taxable bonds from lowest yielding to highest yielding.
I)U.S.Treasury bonds
II)Corporate bonds
III)Agency bonds

A) I, II, III
B) II, I, III
C) III, II, I
D) I, III, II

Question 10

Municipal bonds usually have higher yields than bonds issued by the U.S.Government.

Question 11

Treasury bond yields are commonly used as the basis for yield curves because they are low risk and homogeneous in nature.

Question 12

The required return on a bond is equal to

A) the real rate of return plus a risk premium plus an expected inflation premium.
B) the real rate of return plus the coupon rate plus an inflation rate.
C) the risk-free rate plus a risk premium plus an expected inflation premium.
D) the real rate plus a risk premium.

Question 13

Which of the following risks are included in the risk premium?
I)interest rate risk
II)liquidity risk
III)financial risk
IV)purchasing power risk

A) I and II only
B) II and III only
C) III and IV only
D) I and IV only

Question 14

The risk-free rate of return is equal to the

A) real rate plus a risk premium.
B) required return minus the inflation premium.
C) real rate plus the inflation premium.
D) required return minus the real rate.

Question 15

The higher a bond's Moody's or Standard & Poors rating, the higher its yield.

Question 16

Which of the following factors will tend to cause the risk free rate to rise?
I)An increase in the money supply.
II)An increase in the federal budget deficit.
III)An increase in the level of economic activity.
IV)Falling rates in foreign markets.

A) I, II, III only
B) II, III only
C) I and IV
D) I, II, III, and IV

Question 17

As the Federal Government's budget deficit rises, interest rates tend to fall.

Question 18

Which one of the following statements concerning interest rates is correct?

A) A decrease in the money supply will cause interest rates to decline.
B) A federal budget surplus will cause interest rates to decline.
C) Economic expansions will cause interest rates to decline.
D) Rising interest rates in foreign countries will cause U.S. interest rates to decline.

Question 19

The real rate of interest is the risk free rate minus the inflation premium.

Question 20

Predicting the direction of interest rate movements is relatively easy.

Question 21

The market segmentation theory holds that

A) an increase in demand for long-term borrowings leads to an inverted yield curve.
B) expectations about the future level of interest rates is the major determinant of the shape of the yield curve.
C) the yield curve reflects the maturity preferences of financial institutions and investors.
D) the shape of the yield curve is always downsloping.

Question 22

If the yield curve begins to rise sharply, it is usually an indication that

A) stocks are offering low returns as the economy enters a recession.
B) inflation rates have peaked and are about to decline.
C) bond prices are expected to increase.
D) inflation is starting to increase, or is expected to do so in the near future.

Question 23

A normal yield curve is flat or downward sloping.

Question 24

According to the expectations hypothesis, investors' expectations of decreasing inflation will result in

A) a downward-sloping yield curve.
B) an upward-sloping yield curve.
C) a flat yield curve.
D) a humped yield curve.

Question 25

Long-term bonds are ________ than short-term bonds.

A) less risky
B) more liquid
C) subject to more uncertainty
D) less sensitive to interest rate changes

Question 26

According to the liquidity preference theory, borrowers should pay a higher interest rate for long-term borrowing than for short-term borrowing.

Question 27

A flat or downward sloping yield curve indicates that the economy may be heading toward a recession.

Question 28

The liquidity preference theory supports ________ yield curves.

A) upsloping
B) flat
C) humped
D) downsloping

Question 29

A steep yield curve is generally considered a bullish sign for bonds.

Question 30

The expectations hypothesis states that investors

A) require higher long-term interest rates today if they expect higher inflation rates in the future.
B) expect higher long-term interest rates because of the lack of liquidity for long-term bonds.
C) require the real rate of return to rise in direct proportion to the length of time to maturity.
D) normally expect the yield curve to be downsloping.

Question 31

A down-sloping yield curve indicates that interest rates are about to rise.

Question 32

An inverted yield curve

A) means that long-term bonds are yielding more than short-term bonds.
B) exists when intermediate-term bonds have higher yields than either short-term or long-term bonds.
C) rewards long-term investors for the additional risk they are assuming.
D) generally results from actions by the Federal Reserve to control inflation.

Question 33

If inflation is expected to increase significantly, cautious bondholders should

A) expect interest rates to rise.
B) expect a flat yield curve for the intermediate-term.
C) buy long-term bonds today.
D) move to the short-end of the yield curve.

Question 34

The yield curve depicts the relationship between a bond's yield to maturity and its

A) duration.
B) term to call.
C) term to maturity.
D) volatility.

Question 35

At any given time, the yield curve is affected by
I)lender preferences.
II)inflationary expectations.
III)liquidity preferences.
IV)short- and long-term supply and demand conditions.

A) I and IV only
B) II, III, and IV only
C) I, II and III only
D) I, II, III and IV

Question 36

Market segmentation theory explains the typical upward sloping shape of yield curves as a function of

A) normally greater demand for long-term bonds than for short-term notes.
B) normally greater demand for short term notes than for long-term bonds.
C) expectations that inflation will be higher in the future than it is now.
D) the greater liquidity of short-term notes as compared to long-term bonds.

Question 37

Downward sloping or flat yield curves often indicate

A) a recession in the near future.
B) an economic expansion in the near future.
C) higher inflation in the near future
D) a weaker dollar in the foreign exchange markets.

Question 38

Evidence indicates that the theory of interest rates with the most predictive power is

A) market segmentation theory.
B) expectations theory.
C) liquidity preference theory.
D) a combination of expectations, market expectations and liquidity preference.

Question 39

According to the expectations hypothesis, if investors anticipate higher rates of inflation in the future, the yield curve will be downsloping.

Question 40

The real rate of return is the same for all maturities.

Question 41

A bond's discount or premium will tend to increase as the bond approaches its maturity date.

Question 42

There is normally an indirect relationship between the coupon rate of a bond and the bond's yield.

Question 43

What is the current price of a $1,000, 6% coupon bond that pays interest semi-annually if the bond matures in ten years and has a yield-to-maturity of 7.1325%?

A) $567
B) $920
C) $1,030
D) $1,080

Question 44

A $1,000 par value, 12-year annual bond carries a coupon rate of 7%.If the current yield of this bond is 7.995%, its market price to the nearest dollar is

A) $876.
B) $925.
C) $1,075.
D) $1,125.

Question 45

A bond's yield to maturity is equal to the internal rate of return of its cash flows.

Question 46

Bonds with the same level of risk, the same maturity, and the same coupon rate will always sell for the same price whether the interest is paid annually, semi-annually or quarterly.

Question 47

Which of the following are needed to determine the appropriate value of a bond?
I)required rate of return
II)time to maturity
III)frequency of interest payments
IV)coupon rate

A) II and III only
B) III and IV only
C) II, III and IV only
D) I, II, III and IV

Question 48

The shorter the time to maturity, the less sensitive a bond's price will be to changes in interest rates.

Question 49

What is the yield-to-maturity of a $1,000, 7% semi-annual coupon bond that matures in 2 years and currently sells for $997.07?

A) 6.87%
B) 7.04%
C) 7.16%
D) 7.31%

Question 50

The price of a bond is equal to the present value of the bond's future cash flows.

Question 51

The price of a bond with an 8% coupon rate paid semi-annually and a par value of $1,000, and fifteen years to maturity is the present value of

A) 15 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
B) 15 payments of $80 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
C) 30 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
D) 30 payments of $80 at 1 year intervals plus $1,000 received at the end of the 30th year.

Question 52

Bond yields are set by the bond issuer.

Question 53

Explain how a yield curve is constructed and what its shape reveals about interest rates.

Question 54

What is the coupon rate of an annual bond that has a yield to maturity of 8.5%, a current price of $942.32, a par value of $1,000 and matures in thirteen years?

A) 7.67%
B) 7.75%
C) 8.33%
D) 8.50%

Question 55

If a bond's yield to maturity is lower than its coupon rate, the bond will sell at a discount.

Question 56

A basis point is 1/10 of 1%.

Question 57

Generally speaking, long-term bonds have lower yields than short-term bonds.

Question 58

What is the current price of a 9%, $1,000 annual coupon bond that has eighteen years to maturity and a yield to maturity of 9.631%?

A) $898
B) $935
C) $942
D) $947

Question 59

The required return defines the yield at which a bond should be trading and serves as the discount rate in the bond valuation process.

Question 60

A significant portion of a coupon bond's total return is derived from the reinvestment of the interest payments.

Question 61

The greater of the yield-to-call or the yield-to-maturity is used as the appropriate indicator of value.

Question 62

Which of the following statements concerning the current yield is correct?

A) It is of great interest to aggressive bond investors seeking capital gains.
B) It is of great interest to conservative bond investors seeking current income.
C) It shows the rate of return an investor will receive by holding a bond to maturity.
D) It can be determined by dividing interest income by the par value of a bond.

Question 63

The reinvestment rate assumption is more important
I)the longer the time to maturity.
II)the shorter the time to maturity.
III)the higher the coupon rate.
IV)the lower the coupon rate.

A) I and III
B) I and IV
C) II and III
D) II and IV

Question 64

Which one of the following statements is true about a $1,000, 6% annual coupon bond that is selling for $1,012?

A) The current yield is less than 6%.
B) The current yield is 6%.
C) The yield-to-maturity is greater than 6%.
D) The yield-to-maturity is 6%.

Question 65

Yield to call is a useful measure for bonds selling at a premium, but not for bonds selling at a discount .

Question 66

Bond duration refers to the remaining life of a bond.

Question 67

The actual return earned on a bond is highly dependent upon the reinvestment rate of the coupons.

Question 68

If you are an income-oriented investor and you feel that interest rates are relatively high and will decline in the future, you should purchase

A) zero-coupon, long-term bonds.
B) long-term, non-callable bonds.
C) short-term, zero-coupon bonds.
D) long-term, freely callable bonds.

Question 69

The current yield on a bond is most similar to

A) the discount rate on a Treasury Bill.
B) the effective annual rate on a certificate of deposit.
C) the dividend yield on a stock.
D) the internal rate of return if the bond is held to maturity.

Question 70

The yield-to-maturity (YTM)approach fails to consider which of the following risks?
I)reinvestment risk
II)price or market risk

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 71

Yield to call on a bond with a coupon rate of 8% paid semi-annually, 10 years to maturity, a par value of $1,000 and a selling price of $1,071, callable after 5 years at $1,010 is

A) 3.5%.
B) 6.49%.
C) 7.0%.
D) 8.16%

Question 72

Which one of the following statements is correct concerning bond investors?

A) Aggressive investors want to lock in high interest rates.
B) Aggressive investors purchase bonds when they believe interest rates will rise.
C) Conservative investors seek capital gains.
D) Conservative investors buy bonds when interest rates are high.

Question 73

The conventional way to calculate the bond-equivalent yield (BEY)for a bond is to

A) divide the coupon rate by 2.
B) multiply the semi-annual yield by 2.
C) subtract the approximate yield from the promised yield.
D) calculate the effective annual yield.

Question 74

Which of the following statements are correct concerning yield-to-maturity (YTM)?
I)YTM considers both interest income and price appreciation.
II)YTM assumes the bond is called at the earliest possible date.
III)YTM is a compounded rate of return.
IV)YTM assumes all interest payments are reinvested at the YTM rate.

A) I and IV only
B) I, III and IV only
C) II, III and IV only
D) I, II and III only

Question 75

The actual return on a bond is dependent upon which of the following?
I)the coupon rate
II)the reinvested interest rate
III)any changes in par value
IV)any changes in market price

A) I, II and III only
B) II, III and IV only
C) I, III and IV only
D) I, II and IV only

Question 76

Yield-to-call assumes a bond is called on the last possible date.

Question 77

A bond is most likely to be called

A) when investors must reinvest at lower rates.
B) when the bond sells at a large discount.
C) when market yields are close to coupon rates.
D) when investors can reinvest at higher rates.

Question 78

Yield-to-call is

A) commonly used for bonds with deferred-call provisions.
B) calculated using the time to call and the par value of the bond.
C) based solely on the call premium and ignores interest payments.
D) always less than the yield-to-maturity.

Question 79

The value of a bond can be calculated several different ways, depending on the investor's objectives.Conservative, income-oriented bondholders will typically use

A) promised yield, whereas aggressive bond traders are likely to use expected return.
B) expected return, whereas aggressive bond traders are likely to use promised yield.
C) realized yield, whereas aggressive bond traders are likely to use holding period return.
D) holding period return, whereas aggressive bond traders are likely to use realized yield.

Question 80

Explain the differences between yield-to-maturity and yield-to-call.